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Discriminatory Effects of Credit Scoring on Communities of Color

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Discriminatory Effects of Credit Scoring on Communities of Color Discriminatory Effects of Credit Scoring on Communities of Color Lisa Rice* & Deidre Swesnik** TABLE OF CONTENTS I. INTRODUCTION ............................................................................................ 936 II. THE NATION’S DUAL CREDIT MARKET ROOTED IN DISCRIMINATION ....... 940 A. Overt Historical Discrimination .................................................... 940 B. Subprime Lending and Its Long-Term Discriminatory Effects ..... 943 C. The Proliferation of Fringe Lenders in Communities of Color ...... 947 III. CREDIT SCORING HAS A DISCRIMINATORY IMPACT AND IS NOT THE BEST MEASURE OF RISK ...................................................................... 949 A. Limited Scope, Quality, and Transparency of Credit Information .................................................................................. 950 B. Disparate Impact of Credit-Scoring Factors .................................. 952 1. Payment History: 35% of FICO Score ................................... 953 2. Amounts Owed: 30% of FICO Score .................................... 954 3. Length of Credit History: 15% of FICO Score ...................... 955 4. New Credit: 10% of FICO Score ........................................... 956 5. Types of Credit Used: 10% of FICO Score ........................... 957 C. Existing Credit-Scoring Systems Do Not Adequately Predict Risk .............................................................................................. 957 D. Risky Loan Products and Unsafe Lending Environments⎯Not Borrowers⎯Were Clearly the Culprit ......................................... 960 IV. WHY THE FEDERAL GOVERNMENT AND LENDERS HAVE AN OBLIGATION TO CHANGE THE SYSTEM ................................................ 961 V. POLICY AND ENFORCEMENT SOLUTIONS TO IMPROVE CREDIT-SCORING SYSTEMS .............................................................................................. 962 A. Broaden the Scope of Financial Data Utilized by Underwriting and Credit Scoring Models .......................................................... 963 * Vice President, National Fair Housing Alliance. ** Director of Public Policy and Communications, National Fair Housing Alliance. About the National Fair Housing Alliance (NFHA): Founded in 1988 and headquartered in Washington, DC, NFHA is a consortium of more than 220 private, nonprofit fair housing organizations, state and local civil rights agencies, and individuals from throughout the United States. Through comprehensive education, advocacy, and enforcement programs, NFHA protects and promotes equal access to apartments, houses, mortgage loans, and insurance policies for all residents of the nation. 936 SUFFOLK UNIVERSITY LAW REVIEW [Vol. XLVI:935 B. Improve the Quality of Data .......................................................... 963 C. Make the System More Transparent .............................................. 964 D. Adequately Assess the Impact of Credit-Scoring Mechanisms on Underserved Groups ............................................................... 964 E. Reduce the Overreliance on Credit-Scoring Mechanisms ............. 964 F. Evaluate Product Risk .................................................................... 964 G. Fix Credit Scores for Victims of Discrimination ........................... 965 VI. CONCLUSION ............................................................................................ 965 I. INTRODUCTION Our current credit-scoring systems have a disparate impact on people and communities of color. These systems are rooted in our long history of housing discrimination and the dual credit market that resulted from it. Moreover, many credit-scoring mechanisms include factors that do not just assess the risk characteristics of the borrower; they also reflect the riskiness of the environment in which a consumer is utilizing credit, as well as the riskiness of the types of products a consumer uses. Until only a few decades ago, communities and people of color were explicitly excluded from access to low-cost government and other mainstream loans. In the 1930s, the Home Owners Loan Corporation (HOLC) used blatant discriminatory rating systems and “residential security maps” to deem communities of color to be high risk.1 The Federal Housing Authority (FHA) and Veterans Administration (VA) continued this discrimination into the 1950s.2 Banks, real estate agents, appraisers, and others also perpetuated redlining and segregation in the housing markets. The passage of the federal Fair Housing Act of 1968 improved conditions, but federal regulatory agencies refused to acknowledge their enforcement responsibilities under the Act until the mid 1970s. It was not until civil-rights groups sued the agencies that the federal government began to collect information on the mortgage-lending practices of the institutions it regulated, and to establish and implement fair- lending examination procedures. Because of this history of racial discrimination, segregated neighborhoods formed and people of color had limited access to affordable, sustainable credit. Instead of accessing mainstream credit available to white borrowers and white neighborhoods, people of color were relegated to using fringe lenders and paying much more than they would have had to otherwise. While segregation 1. See DOUGLAS S. MASSEY & NANCY A. DENTON, AMERICAN APARTHEID: SEGREGATION AND THE MAKING OF THE UNDERCLASS 52 (1993). 2. See William J. Collins & Robert A. Margo, Race and Home Ownership, 1900 to 1990, at 19-20 (Nat’l Bureau of Econ. Research, Working Paper No. 7277, 1999), available at http://www.nber.org/papers/w7 277.pdf (explaining use of Residential Security Maps in issuing loans). 2013] DISCRIMINATORY EFFECTS OF CREDIT SCORING 937 and housing discrimination have abated somewhat, we still live in an extraordinarily segregated society.3 Access to credit is even now often based on where we live rather than our individual ability to repay that credit. As this Article will explore, people of color were steered to subprime loans even when they qualified for prime loans, contributing to the fact that the foreclosure crisis has hit communities of color worse than the rest of the country.4 Credit-scoring systems in use today continue to rely upon the dual credit market that discriminates against people of color. For example, these systems penalize borrowers for using the type of credit disproportionately used by borrowers of color. Even fair-lending defense attorneys who represent major banks readily admit that credit scoring has a differential impact on people of color. In a recent article, attorneys at K&L Gates asserted “even the most basic lending standards, such as credit scores and [loan-to-value] requirements, ‘impact’ racial and ethnic groups differently.”5 While some in the financial industry have recently discussed the existence of the disparate-impact theory under the Fair Housing Act and other long-established laws, all eleven circuit courts that have considered the matter recognized disparate impact as a legally acceptable means by which parties can assert claims under the Act.6 As we all look for solutions to the foreclosure crisis, lenders, regulatory agencies, and policymakers promote tighter underwriting standards as a solution to improving the quality of loan performance and strengthening the economy. What they mean in part, however, is requiring higher credit scores for the best and most affordable products. This, of course, places the focus of improving loan performance on borrowers. But many studies and analyses have demonstrated that inappropriate loan products and their components were 3. Craig Gurian, New Maps Show Segregation Alive and Well, REMAPPING DEBATE (Apr. 20, 2011), http://www.remappingdebate.org/map-data-tool/new-maps-show-segregation-alive-and-well (explaining segregation’s continuing presence in America). For example, according to 2010 census numbers, 65% of individuals in large metropolitan areas still live in areas of high segregation between whites and African- Americans. See id. 4. See infra Part II.B. 5. Paul Hancock et al., Supreme Court vs. HUD: The Race to Decide “Impact or Intent”, K&L GATES (Nov. 17, 2011), http://www.klgates.com/emsupreme-court-vs-hudem--the-race-to-decide-impact-or-intent-11- 17-2011. 6. See Press Release, Consumer Fin. Prot. Bureau, Consumer Financial Protection Bureau To Pursue Discriminatory Lenders, (Apr. 18, 2012), http://www.consumerfinance.gov/pressreleases/consumer-financial- protection-bureau-to-pursue-discriminatory-lenders (announcing Bureau targeting unlawful lending practices including disparate impact). In addition, since the Fair Housing Act was amended in 1988, the United States Department of Housing and Urban Development and United States Department of Justice have acted in administrative proceedings and other contexts with the full understanding that disparate-impact claims are cognizable under the Act. See id. Further, the Consumer Financial Protection Bureau (CFPB) recently announced that it would utilize all tools, including disparate-impact theory, to pursue lenders who discriminate against consumers in violation of the Equal Credit Opportunity Act (ECOA). See id. The CFPB specifically stated that it would use disparate-impact theory when bringing actions under the ECOA. See id. The Federal Reserve also recognizes disparate impact as a way to prove ECOA claims. See id. 938 SUFFOLK UNIVERSITY LAW REVIEW [Vol. XLVI:935 key factors driving the subprime crisis.7 Factors including product type, presence
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